Insurance Concepts - Part 1 - Risk

What's a Risk ? 

When you read you begin with A-B-C
We can take a cue from this number –When you try to understand Insurance, you begin with the Concept of Risk…

 Risk is defined as uncertainty concerning the occurrence of a loss. e.g. The risk of being killed in an auto accident, the risk of lung cancer for smokers, etc.

Types Of Risks

There are many kinds of Risks, out of which a couple are important for understanding Insurance. They are:

Pure Risk

Pure Risk is defined as a situation in which there are only the possibilities of loss or no loss. The only possible outcomes are adverse (loss) and neutral (no loss).

e.g. Premature death, job-related accidents, catastrophic medical expenses, damage to property from fire, lightning, flood, or earthquake.

Speculative Risk

It is defined as a situation in which either profit or loss is possible. e.g. Share/Stock trading, betting on a horse race, investing in real estate, etc.

 It can be seen that in the above situations, both profit and loss are possible.Only Pure Risks are Insured by the Insurers. Speculative Risks generally are not considered insurable, and other techniques for coping with speculative risk must be used.

Pure Risks are further classified into following categories

Personal Risks

These are the risks that directly affect an individual. E.g. premature death, insufficient income during retirement, poor health, etc.Property Risks

Property Risks

The risk of having property damaged or lost from numerous causes.Direct Loss

It is defined as a financial loss that results from the physical damage, destruction, or theft of the property. E.g. A restaurant that is damaged by a fire, the physical damage to the restaurant is known as a direct loss.Indirect or Consequential Loss

An indirect loss is a financial loss that results indirectly from the occurrence of a direct physical damage or theft loss. E.g. loss of profits, loss of rents, the loss of the use of the building, the loss of a local market, Extra expenses, etc. Liability Risks

Under legal system, one can be held legally liable if he/she do something that results in bodily injury or property damage to someone else. E.g. A court of law may order to pay substantial damages to property or the injured person.

Liability Risks

Unpredictable as there is no maximum upper limit with respect to the amount of the loss claimed

a lien can be placed on income and/or financial assets to satisfy the liability

legal / defense costs can be astronomical